Canadian Credit Health Update

2010-09-10

Introduction

I plan on releasing these Canadian
Credit Health Updates approximately every quarter. In these reports,
I apply the same analysis techniques that I used when watching the
American financial system through 2005-2009. If American and
European-style problems develop in Canada, I expect that these
metrics will show early warning signs just as they did in the USA.
All data comes from public financial reports.

Why watch these numbers?

In the modern economy, credit is the
key factor. Credit (loan) quality ties directly to bank health and
can indicate problems long before a bank is pushed to the brink of
insolvency. But this isn't just about bank health and safety of
deposits. Loans backed by real estate collateral underpin balance
sheets throughout the economy. This means that loan quality problems
translate into problems in banks, business, households, and even the
government (for example the US Government pays Fannie Mae's ongoing
mortgage losses). On top of this, impacts of credit are amplified
through leverage, both
personal and bank. Canada is very highly leveraged, and this is why
we need to watch the situation.

B.
Gross impaired loans / Total assets (higher = worse balance sheet):
A quick measure of deterioration on the asset side of the balance
sheet. In the USA, banks started having major problems at 1.5%, and
critical problems including insolvency above 2.0%.

Bank

2010.Q3

TD

0.55%

CIBC

0.58%

Royal Bank

0.71%

BMO

0.79%

Scotiabank

1.03%

C.
Gross impaired loans / Tier 1 capital (higher = worse balance sheet):
This measure is very similar to the Texas Ratio, and compares the bad
loans to Tier 1 (Basel II) capital, the core measure of bank capital
which is primarily equity. If bad loans are a large % of the bank's
capital, it means the bank can not easily absorb the losses.

Bank

2010.Q3

CIBC

13.5%

TD

14.1%

BMO

14.7%

Royal Bank

15.0%

Scotiabank

21.6%

D.
Tier 1 Leverage ratio (lower = higher leverage):
This doesn't measure loan quality, but rather the bank's leverage and
aggressiveness. Tier 1 leverage = tier 1 capital / total assets. This
measure is included because higher leverage translates to greater
overall risk. The banks with the worse loan books (above tables)
should exhibit lower leverage, otherwise it means they are being far
too aggressive for their condition.

Bank

2010.Q3

BMO

5.3%

Scotiabank

4.8%

Royal Bank

4.8%

CIBC

4.3%

TD

3.9%

Big Five
Bank Analysis

Royal Bank,
BMO, and Scotiabank have the worst loan books. Scotiabank in
particular is an outlier with particularly bad loans. On leverage the
situation is sensible, with TD and CIBC (best loan books) showing the
highest leverage.

Bankruptcy
Statistics

These
numbers lag by quite a bit, but they are still valuable: this shows
total Canadian bankruptcies over time. Bankruptcy rates closely
relate to bank loan quality. Bankruptcy rates have come down sharply
from the peak of the crisis.